On the compensation for illiquidity in sovereign credit markets

Jonatan Groba and Juan Angel Lafuente

DEE - Working Papers. Business Economics. WB from Universidad Carlos III de Madrid. Departamento de Economía de la Empresa

Abstract: This article analyzes the role of liquidity in the sovereign credit default swap (CDS) market. We employ a continuous-time specification to incorporate illiquidity as an additional pricing factor of default swap contracts for the most developed economies. The illiquidity discount process is identified as compensation to investors for the risk of unwinding their positions when trading in the less liquid part of the curve, and the information about illiquidity is directly extracted from the term structure of sovereign CDS spreads. Our empirical findings reveal that a positive time-varying illiquidity premium is embedded in sovereign default swaps. These risk premia exhibit substantial comovement across countries. Only unidirectional causality from default toliquidity is detected for the overall market

Keywords: Credit; default; swap; Illiquidity; Default; Risk; premium (search for similar items in EconPapers)
JEL-codes: F30 G12 G13 G32 (search for similar items in EconPapers)
Date: 2014-10
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Journal Article: On the compensation for illiquidity in sovereign credit markets (2015)
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Persistent link: https://EconPapers.repec.org/RePEc:cte:wbrepe:wb142911

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